Sources of Risk for Grain and Farm Supply Cooperatives

Phil Kenkel

Bill Fitzwater Cooperative Chair

Oklahoma State University

Grain and farm supply cooperatives operate in a risky environment.   One of the key responsibilities of the board and management is to mitigate risks consistent with the cooperative’s risk capacity.  During the last few months I have been working on a simulation tool to help cooperative managers and boards better understand and manage the risks facing their cooperative.  Each cooperative is unique, and the firm’s complete risk profile can be understood only through an in-depth enterprise risk management assessment.  However, there are major sources of risks such as grain volume and grain margin, fertilizer volume and fertilizer prices and accounts receivables that are similar across cooperatives.

As an illustration, one can consider a typical cooperative which is represented by the composite financial statements of all Oklahoma cooperatives in the CoBank database.   This example cooperative has a grain volume of 3M bushels, 12,000 tons of fertilizer sales and total sales of around $28M.  When all volumes and margins are set at historic averages the cooperative has before patronage profits of around $900,000 including $166,000 of regional patronage. The cooperative has a return on assets of over 20% and a return on equity of 30% reminding us how easy life would be if weather and market volatility disappeared.

Volatility was modeling using historic variation in wheat yields at the county level, weekly fertilizer prices at the wholesale level and weekly grain basis.  The variation in fertilizer volume was modeled from USDA data on annual fertilizer sales at the state level.  Not surprisingly, grain volume is the largest source of variation in the cooperative’s cash flow.  Grain volume accounts for around two thirds of the total risks modeled.  Fertilizer price risk accounts for around 10% of total risk while grain margin risk accounts for around 5%.  The remainder of risks for this hypothetical cooperative come from price and volume fluctuations in other farm supply categories and the variation in equity redemption payments.

The simulator provides a tool for a cooperative to take an initial look at risk exposure and/or examine equity retirement systems.  If your cooperative is interesting in being a guinea pig, let me know.  In my next newsletter I will discuss how equity management and patronage decisions influence risk.  That is also part of the exciting case study at next week’s advanced OCCD program.